UK banks grapple with threat of 5 pct leverage ratio

* Banks could restrain 2015 dividends in face of tougherrules

* Friday deadline for banks to respond to leverage proposals

* UK add-ons could see leverage ratio at minimum 4-5pct-bankers

By Steve Slater

LONDON, Sept 11 (Reuters) - For Britain's under-fire banks atorrent of regulatory challenges passes another marker on Fridaywith a deadline for views on a reform of their "leverage"ratios, a key measure of their level of insulation againstfuture financial crises.

Industry insiders see the implications of the reform assignificant.

Expectations are that banks may be required to raise theirleverage ratios to as high as 5 percent, from a current 3percent, implying a further multi-billion pound stockpiling ofcapital to shield them from future losses.

One senior executive at a UK bank said a 5 leverage ratiowould be "a huge game changer" for banks and hurt their appetitefor mortgage lending - underscoring the potential broadereconomic impact of the way the sector is regulated.

Others warn it will pressure banks to restrain their levelof dividend payments, as the sector also grapples with broader"stress tests" of their finances being conducted at Europeanlevel and other rules targeting their capital levels.

Morgan Stanley analyst Chris Manners estimated dividendpayouts next year will be 30 percent below current expectations.Analysts on average predict decent dividend rises at all banksother than Royal Bank of Scotland (RBS), but Mannerspredicted only HSBC and Lloyds will increase,and by modest amounts.

"We do expect the rising leverage ratios, coupled with therising common equity bar towards a steady state of 12 to 13percent and upcoming stress tests, means the pressure willremain to retain capital," Manners said.

Banks have until Friday to respond to proposals for theleverage ratio framework set out by the BoE's Financial PolicyCommittee (FPC). The FPC will finalise plans in November,although it will not set the minimum level banks have to reachuntil around mid-2015, industry sources said.

The top banks and the British Bankers' Association lobbygroup declined to give any details of their responses to theconsultation.

The FPC's consultation paper made clear it may add several"top ups" to the basic leverage ratio, such as a "conservationbuffer" that lenders build up during good times, or an add-onfor big banks to make rules more stringent for the biggestlenders.

Britain's top five banks - HSBC, Lloyds, Barclays,RBS and Standard Chartered - could have a 46 billionpound capital shortfall if they had to meet a 5 percent leverageratio this year - including a 24 billion pound gap at Barclays -but they should be able to close that hole by 2017, MorganStanley estimated.

Either way, the leverage ratio - a simple measure of capitalas a percentage of assets that takes no account of the riskinessof loans - looks certain to become a more important driver ofhow much capital banks hold, bankers and analysts say.

MORE IMPORTANT

Up to now regarded as a "backstop" to the more importantrisk-weighted capital ratios, the leverage ratio appears set torise to at least 4 percent and possibly to 5 percent, severalbankers told Reuters, based on their interpretation of the FPCconsultation document.

To soften the impact, banks are likely to be given betweenthree and five years to get to that level.

"We assumed it wasn't stopping at 3 percent, we assumed itwasn't stopping at 4 (percent)," Tom King, head of Barclays'investment bank, said this week in reference to the leverageratio Barclays planned for when it set a new strategy in May.

"So whether it's 5 (percent) or north of five, we thinkgiven a sensible glide path we can get there without impactingRoEs (return on equity targets)," King told investors.

Banks are not expected to have to rush out and raise equityto meet the new rules, unlike last year, when Barclays raised 6billion pounds in a rights issue after the Bank of Englandforced it to quickly improve its leverage, and building societyNationwide also had to raise cash.

Banks are already improving ratios to avoid the need forradical action by retaining earnings, issuing bonds that canconvert into equity and slashing assets, because investorstypically prefer them to meet regulatory levels early.

Improving its leverage ratio is a key part of Barclays' planto shrink its assets and the bank's ratio rose to 3.4 percentfrom 3 percent in the first six months of this year, as it shed100 billion pounds of assets.

Yet the threat of a more stringent leverage ratio continuesto raise concerns.

Building societies have slammed the FPC proposals as a"primitive approach" that discriminated against them, aslow-risk residential mortgages make up the bulk of their loanbooks.

Others said the attraction of the leverage ratio was itssimplicity, and the FPC risked making the rules too complex.

Global regulators have set a minimum standard of 3 percent,but that could be increased in two to three years and Britainand the United States are among those looking to go further,driven by concern that banks can "game" risk-weighted capitalratios and they do not reflect the true risk of loans.

The FPC could also limit banks' use of so-called hybridcapital to help their leverage ratio, potentially limiting theusefulness of bonds that several banks have sold in the pastyear, which convert into equity if a bank hits trouble. (Editing by David Holmes)